You’re not rational: behavioural finance could save billions

A business that sits at the intersection of finance and psychology and that could save investors billions of dollars each year is set to launch in Australia.

Behavioural Finance Australia (BFA) will launch in August, and could help the country’s self-directed share investors and their advisers overcome hidden psychological influences on their decision making.

International studies have shown that these effects cost small investors billions of dollars each year, even though they’re probably unaware of it. One study in Taiwan showed losses of 3.8% per annum, or the equivalent of 2.2% of GDP.

“In an Australian context that’s like wiping out the utilities industry every year – it’s remarkably large,” said BFA director Simon Russell.

Russell, who is backed by qualifications in psychology, finance and financial planning, told Wealth Professional that internationally there’s been increased interest in behavioural finance effects since the GFC.

However, it’s never really been introduced to Australian turf.

“Until recently finance has been based on the premise that we’re all making rational decisions, but the GFC has highlighted that the model is broken,” he said. “Some of the stuff I find most fascinating is a.) Things beyond conscious awareness; and b.) That people will flat-out deny that it’s happening.”

Recent studies include one simple one, where a group of investors entered a test-room to make investment decisions. In the hallway that led to the room there was a picture on the wall.

For one group it was a smiley face, and for the other, a sad face.

The results revealed that the group who walked past the happy face made more investments and riskier decisions than the other.

Another of the most well documented studies is called the Disposition Effect - a tendency for investors to sell stocks that rise, and hold those that fall. We celebrate a small victory on the profitable trade and console ourselves that the other will rebound.

However, momentum effects mean that stocks that rise tend to continue rising, and those that fall continue to drift lower, as least in the short to medium-term.

Russell said behavioural finance is legitimate and science-based, and he expects it will receive more visibility next month with the Behavioural Exchange being held in Sydney.

This conference is being prompted as the world’s first in global public policy and behavioural insights, and some of the top academics and practitioners will be in attendance.

Russell’s BFA business will launch soon after.

He said his broad experience and qualifications that span financial services and include financial advice and accounting, mixed with his psychology background, have made it possible to create something like BFA.

It will take a two-pronged approach, offering opportunities to both self-directed investors and financial planners separately.

“I’m going to take 20-25 of these [behavioural] models and apply them to individual investors. I can objectively look at behaviour and tell them what the impact is and what the solution could be,” he said. “The other half is working with advisers and stockbrokers as partners to train them up [in behavioural finance].”

This will take place in a workshop style environment.

He is currently speaking to financial advisers and stockbrokers interested in completing a one-day accreditation program in Melbourne and Sydney.

Behavioural finance is a new way that advisers can engage with their clients, particularly those who are SMSF investors, Russell said.

“It’s not all about avoiding mistakes though. A behavioural finance savvy investor can take advantage of other people’s behavioural biases,” he said.